Loss mitigation

Alright, the next topic
in the business process,

it also relates to risk management,
and that's loss mitigation.

If you're in the business
of bearing default risk, --

if you can reduce the cost of defaults, --

then you can have
more profitable business, --

regardless of the level of defaults.

So loss mitigation
becomes another important

kind of implementation function.

So one of the first things you do
with loss mitigation

is you have to have a policy.

What do you do --

or what do you want the loan servicer
acting on your behalf to do --

when the borrower is late one payment,

late two payments?

How quickly do you want to foreclose?

Do you want to have
foreclosure alternatives?

Or do you always just want
to foreclose whenever --

the borrower has committed
the legal offenses, so to speak,

that justify foreclosure?

So should there be
foreclosure alternatives?

Now, on a lot of these things,
you're going to face legal constraints.

You might want to foreclose quickly,
but the law doesn't allow it.

And the other constraints; --

which maybe I shouldn't put
in the same category as legal constraints;

I'll put investor constraints
or complications.

So, we'll talk about this more
probably in another video,

but when there are investors
in a mortgage loan,

there are going to be some contractual
obligations that you have, --

if you're bearing the risk
that they're going to cause problems,

or there may be conflicts
between different investor classes

in terms of what would be the most
profitable loss mitigation strategy.

Ultimately, this will take
the form of legal constraints.

The contract terms involved

between the investors
and whoever is servicing the loan.

So back to this issue of
foreclosure alternatives.

There's what's known as a short sale --

where the lender allows
the property to be sold --

for an amount that's less
than the mortgage balance --

and just takes the loss that way.

An advantage of that
is one of the big risks in --

the whole foreclosure procedure is --

that borrowers not only
don't maintain properties,

but they'll actually
steal things out of them.

You know, you can sell the copper wiring
out of the house, for example.

Properties and foreclosure
tend to radically depreciate, --

and so by doing a quick short sale --

convincing the borrower
to sell the property earlier

rather than going through
the foreclosure procedure

saved you some legal expenses, --

and also, it reduces this risk of

the property basically
being gutted by the borrower.

Some companies try, --

as when the borrower
is late with making payments,

some forms of counseling, or --

you can either go through
an expensive process,

a labor-intensive process of
working with the borrowers: --

counseling, working with borrowers.

Or you can try to save on the labor

and you just send out the notice
saying, "Your payment's late," --

and then you send out
the foreclosure notice.

So you can either be
labor-intensive or not.

That's just a choice.

Finally, there's a choice, --

and, again, this may not be available
because of legal or investor constraints,

but you can modify the mortgage.

You can say, "Okay, well, looks like
you can't pay that mortgage,

but maybe we will lower the loan balance,
or we'll lower the interest rate.

We'll do a loan modification."

Loan modifications actually
have a terrible track record.

I just re-mention this;
they have a very high re-default rate.

They had a high re-default rate
in good times,

and to the extent
that they've been tried --

in the most recent housing crisis.

They've had, if anything, an even higher
re-default rate than good times.

So it doesn't work terribly well.
It does not have a good track record.

It's labor-intensive, --

so it imposes a lot of costs
on the servicers because

you really have to make
a lot of judgment calls

about whether a modification will work,

whether it won't work,
how to make it work.

And each case tends to be different, --

so it's a very labor-intensive process.

It doesn't have
a good track record as far as --

saving money in the default process.

I should point out that,
when I talked about legal constraints, --

each state has different rules.

Some of them are designed
to keep borrowers, --

make it harder to foreclose,
some make it easier to foreclose.

The easier it is to foreclose,
usually the less cost and the lower loss.

The harder it is to foreclose, --

the more likely it is that
the lender will lose a lot of money

by the time they get around
to completing the foreclosure process.

So overall, this loss mitigation area
is a very interesting area because --

if it's pretty typical to lose
sort of 50% of the loan amount

when you go through a foreclosure;
and I think that is pretty typical;

then if you could save
a substantial portion of that,

that would be a big deal
in mortgage lending.

That would really improve things a lot.

People often suggest that there are
magic bullets involved in loss mitigation.

So, they'll say, "We think that
if you do X,

maybe you will save substantial
amounts of money."

And the potential is there to do it,
but as far as I know,

none of these things, the short sales,
the counseling, modifying mortgages, --

foreclosure alternatives, --

as far as I know,
none of them is a magic bullet.

Sometimes they save money,

sometimes they make
things worse in the end.

I don't know, --

at least as far as I know now,
there are no --

magic bullets in loss mitigation.

No matter how you do it,
how you deal with it,

with the loan default, --

there's a lot of labor costs involved, --

and there's a lot of
financial losses involved.